What Is Bankruptcy Under Indian Law?

Bankruptcy is a legal status of a person or entity who is unable to repay their outstanding debts. In India, bankruptcy is governed primarily by the Insolvency and Bankruptcy Code (IBC), 2016, which provides a comprehensive framework for resolving insolvency and bankruptcy matters. This code applies to both individuals and companies, and its goal is to ensure timely resolution of financial distress through a structured process, aiming to balance the interests of both creditors and debtors.

What is Bankruptcy Under Indian Law?

Bankruptcy in India refers to the legal process by which an individual or company that is unable to pay back its debts is declared bankrupt, following a legal procedure that allows them to discharge or settle the debts. The Insolvency and Bankruptcy Code (IBC) defines and outlines the process of both individual bankruptcy and corporate insolvency in India.

Insolvency vs. Bankruptcy

While often used interchangeably, insolvency refers to a financial state where an individual or entity cannot meet their debt obligations, whereas bankruptcy is the formal legal process that may follow insolvency, where a person or business is legally declared unable to pay their debts.

Insolvency and Bankruptcy Code (IBC), 2016

The IBC, 2016 is the primary legislation that governs bankruptcy proceedings in India. It provides a uniform and time-bound process for the resolution of insolvency, whether for individuals, companies, or partnerships. It aims to promote entrepreneurship, protect creditor interests, and facilitate the exit of businesses from financial distress.

Key Provisions Under the IBC for Bankruptcy

Corporate Insolvency Resolution Process (CIRP)

For businesses, the IBC introduces the Corporate Insolvency Resolution Process (CIRP). If a company defaults on its debt, creditors can approach the National Company Law Tribunal (NCLT) to initiate CIRP.

During this process, the company is given a moratorium period (typically 180 days, extendable by 90 days), during which no legal action can be taken against the company, allowing time for the resolution of debts or liquidation.

Individual Insolvency and Bankruptcy

For individuals, the Insolvency and Bankruptcy Code (IBC) allows individuals to apply for bankruptcy if they are unable to pay their debts. The process is initiated through the Debt Recovery Tribunal (DRT).

In individual cases, the process helps in resolving debts either through restructuring, recovery plans, or liquidation if no feasible solution is found.

Adjudicating Authorities

The National Company Law Tribunal (NCLT) is the key adjudicating authority for corporate insolvency and bankruptcy proceedings.

The Debt Recovery Tribunal (DRT) is used for individual insolvency cases. Both of these bodies are authorized to manage bankruptcy proceedings and issue directions on liquidation or restructuring.

Creditor’s Role

Creditors play a crucial role in the insolvency process. They are responsible for filing claims and voting on proposed resolutions. In corporate bankruptcy, creditors form a Committee of Creditors (CoC), which takes decisions regarding the resolution plan.

Resolution Plan vs. Liquidation

Resolution Plan:

If a viable plan is agreed upon by the creditors and the corporate debtor, the company may continue its operations under new management.

Liquidation:

If no resolution is found, the company may be liquidated. Assets are sold to repay the creditors.

Moratorium and Asset Protection

During the insolvency process, a moratorium is declared, preventing creditors from initiating or continuing legal actions against the debtor. This provides breathing space to the debtor for either resolving the issue or planning for asset liquidation.

Procedure for Declaring Bankruptcy

Filing the Petition

For individuals or companies, a bankruptcy petition must be filed with the appropriate adjudicating authority (NCLT for companies, DRT for individuals).

In the case of corporate entities, creditors can initiate the process. For individuals, the process can be initiated by the debtor.

Assessment of Financial Position

The financial status of the debtor is thoroughly assessed, including assets, liabilities, income, and expenditures. The goal is to determine the debtor's ability to repay the debts or the need for liquidation.

Appointment of Resolution Professional

A Resolution Professional (RP) is appointed to manage the process of resolving insolvency or liquidation. The RP evaluates the options available, whether it is restructuring the debts or proceeding with liquidation.

Resolution and Approval

A resolution plan is formulated if possible. This plan must be approved by the creditors and the NCLT. If a resolution is not reached, the company or individual may be subject to liquidation.

Liquidation Process

If the debtor cannot repay the debts or reach an agreement with creditors, the debtor’s assets are liquidated to satisfy the claims of creditors.

Legal Consequences of Bankruptcy in India

Discharge from Debt

A debtor can be discharged from most of their debts upon successful completion of the bankruptcy process, although some debts (such as fines, family maintenance, and others) may not be eligible for discharge.

Impact on Credit Score and Reputation

Being declared bankrupt can negatively affect an individual or company’s credit rating and reputation, making future borrowing more difficult.

Asset Liquidation

For both individuals and businesses, liquidation results in the sale of assets to settle debts. This can lead to the loss of property, business assets, and other valuables.

Future Financial Restrictions

The bankrupt party may face restrictions on obtaining loans or conducting business activities in the future until their financial situation is resolved or they are discharged from bankruptcy.

Consumer Safety Tips for Individuals Facing Bankruptcy

Consult a Financial Advisor

Before proceeding with bankruptcy, it’s advisable to seek legal and financial advice to understand the full implications of the process and explore other options like debt restructuring or out-of-court settlements.

Avoid Unnecessary Debt

Maintaining a budget and being mindful of financial commitments can help avoid bankruptcy. If debt begins to accumulate, seek professional advice sooner rather than later.

Explore Debt Restructuring Options

If facing insolvency, debt restructuring or a settlement with creditors can sometimes be a more viable alternative to bankruptcy.

Document All Debts and Assets

Keep a thorough record of all debts, assets, and liabilities. This will help ensure a smoother bankruptcy or insolvency process.

Example

Suppose a small business in India has accumulated significant debts due to poor sales and is unable to pay back its creditors. The creditors, who are owed substantial amounts, decide to initiate bankruptcy proceedings against the business under the Insolvency and Bankruptcy Code (IBC).

Steps the business owner should take:

Consult with a Lawyer

The business owner consults with a legal expert to understand the bankruptcy process.

File a Petition with NCLT

The business owner or creditors file a petition with the National Company Law Tribunal (NCLT) to initiate the Corporate Insolvency Resolution Process (CIRP).

Resolution Plan or Liquidation

A resolution plan is proposed by the creditors. If it is not acceptable, the business may proceed to liquidation.

Asset Sale

The assets of the company are sold off to pay creditors. The company is then either restructured under new management or liquidated completely.